BASD's swaps are investigated by feds

The Bethlehem Area School District has been swept up into a nationwide federal investigation of possible banking industry violations, according to the school district's lawyer.

Solicitor Don Spry confirmed Thursday that the U.S. Securities and Exchange Commission sent him a letter last month seeking documents concerning Bethlehem Area's use of swaps, risky unconventional bond transactions that have blown up in the global financial meltdown. Spry said the SEC's Sept. 17 letter sought the district's records it received from investment banks, J.P. Morgan Chase and Morgan Stanley, which have handled the swaps.

"They were looking at every swap, and not just Bethlehem's," Spry said. "An SEC person told me they were sending these out to every school district and municipality wherever they [J.P. Morgan and Morgan Stanley] worked."

SEC officials declined comment.

Citing the federal investigation, Spry declined to say what Bethlehem records the SEC requested. He said the district sent them Sept. 30. Spry added that his firm -- Spry, Herman, Freund & Faul of Bethlehem -- has not received a similar letter for other governmental clients in the Lehigh Valley or state.

Hundreds of school districts, municipalities and counties in the state have used swaps similar to Bethlehem's, including Easton, Parkland, Nazareth and Souderton, according to records at the Pennsylvania Department of Community & Economic Development. The Morning Call could not determine Thursday if other school districts received similar SEC letters.

"If the SEC wants to come in and investigate, then I welcome them because then it will be one less thing we need to do," said Bethlehem board President Loretta Leeson.

Kevin Ortiz, spokesman for Community & Economic Development, which tracks local government bond deals, said no federal investigative or regulatory agency has contacted the state about swap records.

Morgan Stanley's 2008 quarterly reports include vague language about government investigations. But J.P. Morgan's annual report, issued Feb. 29, is more specific. It says the firm is cooperating with federal probes into its municipal bond deals between 2001 and 2005.

The report states: "The New York field office of the Department of Justice's Antitrust Division and the Philadelphia Regional Office of the Securities and Exchange Commission have been conducting parallel investigations of possible antitrust and securities violations in connection with the bidding or sale of guaranteed investment contracts and derivatives to municipal issuers."

J.P. Morgan's report also says the firm and its subsidiaries are the subject of civil lawsuits stemming from municipal dealings.

Erie and Butler Area school districts have sued J.P. Morgan and their respective financial advisors alleging they colluded to defraud taxpayers on swaps. One of the largest federal investigations involving J.P. Morgan stems from the bank's swaps deals that have nearly bankrupted Jefferson County, Ala.

Swaps are layered on top of government bonds. They are contracts in which a public agency and a third party, typically large investors, bet on weekly rising and falling interest rates.

The theory is if short-term interest rates stay low, municipalities will spend less on interest over the life of the 20- to 30-year bond. Short-term rates historically have been lower than fixed rates of 5 percent or higher.

That hasn't happened in 2008, the worst short-term credit market in U.S. history.

Bethlehem taxpayers are feeling the biggest hit in the area.

State records show no other agency has done more swaps than Bethlehem Area's nine to finance the rebuilding and expansion of most of its 22 schools. The swaps total an estimated $445 million in principal and interest and account for 75 percent of the district's total debt. As a result of spiking interest rates, Bethlehem taxpayers paid an extra $1 million in September.

By contrast, other local school districts are not suffering as bad. Those districts tied about 75 percent into fixed bonds and smaller debt portions into straight adjustable-rate bonds and swaps.

Earlier this month, The Morning Call published a story that showed the swaps were not working in Bethlehem's favor in the summer, before the economic downturn worsened. Then on Monday, two independent financial advisors told Bethlehem officials the district should get out of some of the swaps when the market rights itself as a result of Washington's $700 billion bailout of the financial sector.

But questions concerning Bethlehem's swaps go back eight months. In February, Bloomberg News, a financial media organization, published an investigation into swaps. The article said Pennsylvania school districts, including Bethlehem, paid too much in hidden fees. It pegged Bethlehem's fees at $9.7 million on eight of its nine swaps.